Monday, 28 March 2011

Finding out why African Banks Lend So Little

International donors provide large amounts of financial capital to Africa in the form of aid and grants, but there are also large financial flows in the opposite direction. Many African banks invest large sums abroad and lend relatively little to local businesses.

My co-authors, Svetlana Andrianova, Badi Baltagi, David Fielding and I, explain why in a recent article in vox, drawing on some key findings of a recently completed ESRC project.  For more details click on the link below:

Monday, 15 November 2010

Political Economy Origins of Financial Markets in Europe and Asia

This article, which has just appeared in World Development, highlights the essential role played by governments in kick-starting financial development in Europe and Asia. In the case of London and Amsterdam, the emergence of financial markets was a by-product of the rise of large trading monopolies. These monopolies, partly created to improve public finances, were responsible for all the major financial innovations of the time. In London, for example, the East India Company (EIC), which was granted a royal charter by the monarch to all trade east of the Cape of Good Hope in 1600, was the first to issue permanent stock; this development allowed investors to benefit from risk diversification offered by multiple voyages which, as a result, made investment more attractive. In turned, this helped to boost savings mobilisation, a key to kick starting financial development. The advent of stock trading – which made shares more liquid and therefore more attractive to investors – was facilitated by another EIC innovation, namely a simplified procedure for transferring the ownership of shares.

The paper demonstrates that the EIC’s shares were traded as early as 1661 in the coffee houses of Exchange Alley, before the strengthening of investors’ property rights associated with the ‘Glorious Revolution’ of 1687, emphasised by previous literature as the main turning point in financial history. It ascribes the emergence of London’s financial markets to a deeper cause – the need of the government to improve the state of the public finances and the inability of the monarchy to borrow from investors’ directly due to the erosion of their property rights vis-à-vis the state. It shows that creating profitable and powerful monopolies with close links to government, such as the EIC and later on the Bank of England, was a key not only to the improvement in public finances that ensued but also to the emergence and development of financial markets. The paper also shows that these developments set in motion a virtuous finance-trade-growth cycle that transformed England from a weak state in the early part of the 17th century into Europe’s foremost military power by the beginning of the 18th century.

The experience of Amsterdam was similar to that of London. It also provides an important counter-factual for the analysis relating to the importance of monopolies. The VOC – the Dutch equivalent of the EIC – was established in 1602 following pressure by competitor companies to amalgamate their operations into a monopoly, in order to address the erosion of their profits by excessive competition. Historical sources confirm that the VOC was as much the creation – and later extension - of the Dutch state as it was of the merchants who opened up the East India trade. The birth of the stock market in Amsterdam is firmly linked to trading in VOC shares and so are financial innovations of the time.

In Hong Kong, where the financial development model was bank-based, a large banking monopoly with close links to both the British and Chinese governments, set up to finance international trade played a similar role.

The paper argues that the cases of London, Amsterdam and Hong Kong were not exceptions. The emergence of strong finance in various parts of the world had little, if anything, to do with 'laissez-faire' approaches. Instead it was firmly linked to governments. To illustrate this point, the paper reviews the cases of the Italian city states of Genoa and Venice during the Renaissance, the US state banks in the 18th and 19th centuries and the emergence of strong banking systems in 20th century Japan, Korea and Taiwan.

The paper has been co-authored by Svetlana Andrianova (Leicester) and Chenggang Xu (Hong Kong). The research was funded by the ESRC's World Economy and Finance Research Porgramme.

Andrianova, S., P. Demetriades and C. Xu. Political Economy Origins of Financial Markets in Europe and Asia, World Development (2010), doi:10.1016/j.worlddev.2010.10.001. (available online at Science Direct).

Thursday, 30 September 2010

Don't privatise government-owned banks too soon

The nationalisation of banks as a result of the global economic crisis has been a source of controversy. In an article in VOX that draws on some recent research on government owned banks, Svetlana Andrianova, Anja Shortland and I argue that governments should not feel pressured to re-privatise the banks.

Once the black sheep of high finance, government owned banks can reassure depositors about the safety of their savings and can help maintain a focus on productive investment in a world in which effective financial regulation remains more of an aspiration than a reality.

Further reading:
Svetlana Andrianova Panicos Demetriades Anja Shortland
"There should be no rush to privatise government owned banks", VOX, 20 January 2010.

Creditor Protection and Financial Development in India

In a recent short article in Economics Letters, co-authored with Simon Deakin, Law professor at the University of Cambridge, and Gregory James, Lecturer in Economics at Loughborough University, we utilise a new longitudinal dataset to show that strengthening creditor rights in India during the 1990's and 2000's led to an increase in financial development.

The creditor protection index that we use has been developed by Professor Deakin's team of lawyers at Cambridge. It draws on a wider range of legal materials and a more finely-grained approach to coding than earlier studies by La Porta and co-authors. Specifically, three sub-indices are coded, pertaining to 'debtor control', 'creditor contracts' and 'insolvency law'. Each of the sub-indices contains information on ten or more variables. Professor's Deakin's team has published the index from the mid 1970's to the present day for France, Germany, India, the UK and the US.

Econometric estimations establish that there is a long run relationship between banking sector development and creditor protection. These variables are positively related to GDP per capita, resulting in the co-evolution between the banking system and the real economy. However, when it comes to stock market capitalisation, we find that it is negatively related to banking system development, suggesting there is crowding-out between these two components of the financial system.

Further analysis using the sub-index on creditor contracts suggests that as banks become more significant lenders they press for laws that protect secured credit more effectively. Thus, the evolution of the law itself is part and parcel of the process of financial development.

The work was funded by the ESRC's World Economy and Finance Programme.

The full details of the paper are as follows:

Simon Deakin, Panicos Demetriades and Gregory James "Creditor Protection and Banking System Development in India", Economics Letters, vol. 108, 19-21, (available online at Science Direct).